Dollar Hurdles in the Week Ahead

The US dollar faces several head winds in the days ahead that will likely conspire to cause it to fall in the days ahead.

The technical and fundamental tone of the dollar has deteriorated in recent sessions and further losses are likely in the week ahead. The fact that dollar was not bought on either goods news from the U.S. or poor news from Europe and Japan illustrates a potentially important shift in market psychology.

For example, despite concerns in some quarters that the central bank bid for US debt instruments has faded, the latest weekly Federal Reserve custody shows that simply ain’t true. Foreign officials utilizing the Fed’s custodial services have bought $35.5 billion worth of U.S. Treasuries and Agencies over the past four weeks, which at an annualized rate is a hefty $460 billion. The dollar was not bought on the news.

Well, one might say, that the market typically does not respond to the Fed’ custody data. But the market did not sell the yen either despite news that the Japanese economy grew at only half the pace that the government initially estimated. Rather than expand at a 1.7% annualized pace the revisions indicate the economy grew by only 1%. The revisions also mean that in nominal terms, the economy contracted by 0.2% rather than expand by 0.2% as initially looked to be the case. Yet the dollar could not sustain upticks against the yen.

Disappointing European data similarly failed to weigh on the euro. French industrial production posted its largest decline in 6 years in October. The 2.5% decline, fueled by more than a 9% decline in auto output, compared with consensus expectations for a 0.2% increase. Separately Germany reported not only a smaller than expected Oct trade surplus, but exports, which had been tipped by the PMI and the factory order report, to have risen, actually fell.

In contrast the University of Michigan reported a larger than expected rise in US consumer confidence and still the greenback could trade higher.

Technical Tone Softens

Broadly speaking the dollar rallied against the European currencies from March through June and tended to trade lower over the summer before lunching a new rally starting in early September. Sterling, which often appears to lead moves against the dollar, has successfully violated that downtrend since September. So has the Swiss franc. The euro has lagged behind and has not broken its trend line, which comes in now near $1.1855, falling about 10 ticks a day.

Many short-term market participants are trend followers. One way to identify a trend is to use a 5 and 20 day moving average. When the 5 day crosses above the 20 day, the near-term trend is higher. While acknowledging that in a sideways market, the moving averages can chop one up. The moving averages crossed for the Swiss franc on December and for sterling on December 5. The euro’s moving averages have whipsawed a bit recently as the single currency has been confined to narrow ranges. However, the 5-day crossed above the 20 day on December 8.

Sterling’s advance has bought it with spitting distance of a 38.2% retracement of its September-November decline which comes in near $1.7600. The next retracement objective is seen near $1.7775. The 38.2% retracement of the euro’s downdraft comes in near $1.20. A similar retracement of the dollar against the Swiss franc comes in near CHF1.2890.

Next Week’s Data

There are several U.S. economic reports next week that will likely favor the dollar bears. The market is concerned that the U.S. consumer is over-stretched and the November retail sales report on December 13 is likely to confirm a slowing in consumption. Retail sales excluding autos is expected to be near flat, and possibly negative, after rising 0.9% in October. The next day, the U.S. reports its October trade balance. Although the consensus calls for some narrowing from the $66.1 billion shortfall in September, the risk is for disappointment and for another decline in import prices, dampening another potential source of inflation.

There will be other news that should ease concerns about inflation. The November CPI will be released on December 15. The consensus calls for CPI to have slipped 0.4% after a 0.2% rise in October. The moderation of inflation, and inflation expectations, as reflected nearly 20 bp narrowing of the spread between the inflation-linked securities and the regular 10-year Treasury note, could weigh on the dollar on ideas the Fed’s tightening cycle is nearly done.

On the same day, the U.S. Treasury reports the monthly portfolio flows for October. The $101.9 billion net inflow in September is unlikely to be repeated. A return toward trend is likely. The 12-month moving average is about $71.5 billion which is near the consensus forecast. If there is a surprise, it is more likely on the downside.

FOMC

The Federal Reserve Open Market Committee meets on December 13. Another 25 bp rate hike that will lift the Fed funds target to 4.25% is as done of a deal as these things get. More importantly for the market will be what the Fed says. Here there are two aspects that the market will focus on. First is how the Fed describes current monetary policy. Is it still accommodative? Second is the kind of future guidance the Fed offers. Will it stick to its measured pace phraseology?

Given that the Fed funds rate is near the middle of the range that San Fran Fed President Janet Yellen identified as neutral and that Benjamin Bernanke will soon assume the chairmanship, coupled with the FOMC minutes, the market is well aware that wording of the statement is most likely to change either of the next two meetings, if not both.

There was a time, perhaps in the early summer where a change in the wording might have been interpreted by the market as a signal that perhaps the Fed was considering a 50 bp move. Now is not then. If the wording gets changed last week, the market will likely interpret it as to reaffirm its current view that the Fed is near the end of its tightening cycle. Such an interpretation would likely weigh on the dollar.

There is another central bank that is likely to raise rates next week, the Swiss National Bank. Most expect a 25 bp rate hike, but there has been speculation of a larger 50 bp move. A rate hike by the SNB in any event may also weigh on the dollar insofar as it may reinforce ideas that going forward one of the key supports for the greenback, interest rate differentials, may be diluted.